Oliver Mangan: Price rises not expected to usher in new era of inflation
ECB chief economist Philip Lane last week dismissed the notion of a new era of inflation.
Inflation is picking up globally and Ireland is proving no exception.
A large part of the rise in inflation now underway is due to an unwinding of sharp price falls that occurred last year during the first wave of the pandemic, especially in energy prices.
The Irish inflation rate stood at 1.3% at the start of 2020 and subsequently fell to a low of -1.5% by last October, before finishing the year at -1%.
The rate has picked up sharply in the first four months of 2021, reaching 1.1% by April.
However, excluding energy, the rise in the inflation rate has been much less pronounced, increasing to 0.4% last month from -0.4% in December. Furthermore, much of this rise in non-energy prices is due to the unwinding of last summer’s cut in the standard VAT rate.
An inflation rate of 1% is not going to set any alarm bells ringing, but the Irish rate could well climb to 3% or above by the autumn. Ireland will not have seen an inflation rate like this since 2008.
There are further unfavourable base effects to come in the months ahead from the energy price declines of last year, as well as the VAT cut and other price falls in 2020, such as on clothing, rents and air fares.
There is also upward pressure emerging on global prices in 2021 as economies re-open, with demand rebounding much more quickly than supply. This is being most acutely felt in commodity, raw material and other input prices in the manufacturing and construction sectors.
It reflects disruptions to production, as well as bottlenecks in supply chains, including in transportation, with considerable stains on shipping capacity as global trade rebounds.
It is also likely that we will see some margin widening in sectors that are now re-opening, having being closed for much of the past year or more.
The key question is whether the rise in inflation will prove sustained or not. The ECB’s chief economist Philip Lane last week dismissed the notion of a new era of inflation. He commented that regardless of the current upward pressure on prices, inflation in the eurozone will struggle to meet its 2% target rate over the medium-term, given the amount of slack in labour markets and underlying weakness in economies.
Instead, he views the spike in prices this year as not really inflation, but a temporary misalignment of supply and demand that will unwind. We would add that the marked acceleration in inflation rates in 2021 is also partly due to an unwinding of the price falls that occurred in 2020.
Our expectation is that Irish inflation, as elsewhere, will fall back below 2% next year.
Indeed, the average Irish rate in 2021 should not be much above 1.5% and we envisage broadly similar rates in 2022 and 2023. Recently published forecasts from the Department of Finance contain similar projections.
Thus, it is likely that a jump in the rate to 3% or above by this autumn will prove a temporary phenomenon, though it may attract a lot of comment.
- Oliver Mangan is chief economist at AIB
